There are many reasons why investors prefer to be safe than sorry. Some of them can't stomach the volatility that comes with stock investments. Others may have had a bad experience, which is why they want to stay away. Take for instance HR professional Prakriti Ojha.
She is young, earns well and doesn't have too many liabilities. But ever since she lost money in a mis-sold Ulip, she has stayed away from equity. "I paid Rs 56,000 between 2009 and 2012 and got back only Rs 40,000 when I surrendered the policy," she says. Ojha then vowed to invest only in fixed income instruments.
There could also be valid reasons for investing in low-risk instruments. Nirbhay Morzaria (see picture) is young and earns well. But he has major expenses lined up in the next few years and is investing mostly in debt-based instruments. "I am saving for short-term goals so can't invest in volatile assets," he says. Only 15% of his portfolio is in stocks.
The risk profile of an individual is deter mined by a combination of factors (see chart). Based on the factors that determine risk appetite, we have developed a risk tolerance test (see below). If your score puts you in the low-risk segment, here are some tips for you to optimise your returns.
GO FOR TAX EFFICIENT INVESTMENTS
Bank deposits are all-time favourites of those seeking low-risk instruments.
They are easy to understand, widely available and anyone with a bank account can open one. Thanks to Netbanking, they also do not require paperwork. But bank deposits are tax inefficient because the interest earned is added to your income and taxed at the normal rate. Short-term debt funds can be a better alternative. Although returns from these funds are similar to the interest you earn on FDs, the return is higher if you hold them for more than three years.
There is a misconception that up to `10,000 earned from bank deposits in a year is tax-free. This is not correct. The exemption under Section 80TTA is only for the interest earned on the savings bank balance, not on fixed deposits and recurring deposits. Also, even though five-year FDs are labelled tax-saving deposits, the interest they earn is taxable.
For investors in the 30% tax bracket, the returns from a three-year FD can be as low as 5.6%. On the other hand, gains from a debt fund are taxed at 20% after adjusting for inflation. The net gain is close to 200 bps higher. For salaried people, the Voluntary Provident Fund may be a good option. The EPFO has recommended an interest rate of 8.95% for the current fiscal, which means it will earn equivalent to 12.95% from a bank deposit or bond for subscribers in the highest tax bracket. But the higher rate for the current year could change in coming years. Tax-free bonds, on the other hand, offer assured returns for the entire term.
AVOID LOCKING UP FOR LONG-TERM
Don't put all your money into long-term options. You never know when you may need it. It's best to s plit the investments and create a ladder of deposits. If you have `4 lakh to invest, split the amount in four deposits of `1 lakh each for one, two, three and four years. When the 1-year deposit matures, reinvest the maturity proceeds in the four-year FD. This will ensure liquidity because you have one deposit maturing every year. In case of regular investments, open multiple recurring deposits so that even if you have to close one, the others can continue.
Debt funds offer higher liquidity than other long-term options such as PPF and VPF. You can withdraw from the debt fund or reinvest at any point without any restrictions.
INSURANCE PLANS FORCE SAVING
For some investors, the lack of flexibility can be a boon. Traditional life insurance plans give very low returns but they also force investors to invest for the longterm.
The premium notice sent every year instils a discipline that mutual funds can't. The other good point is that the policyholder cannot dip i nto the corpus before maturity. "We have seen clients start investing for their child's education only to withdraw the money two to three years later to go on a holiday. We recommend insurance plans for such investors. They complain that we are trying to sell them an expensive product but we are just selling them discipline," says Sanjiv Bajaj, MD of Bajaj Capital.
FORMER HAVENS NO LONGER SAFE
As returns of the past three years show, gold is no longer the safe harbour it used to be. Gold prices leapt to `34,000 per 10 grams in 2012. But the metal is now trading at `26,500 per 10 grams, down almost 22% from the peak. Experts say it is unlikely that gold will bounce back in 2016.
If you still want to invest in gold, opt for gold bonds. These bonds are linked to the price of gold and give 2.5% extra returns by way of yearly interest.
The situation is similar in real estate.
Property prices are inflated and home loan interest rates are high. Investing in pr operty now is risky because even if the value appreciates by 5-6%, the 9-9.5% interest you pay will mean a loss in real terms. However, the real estate market is not uniform and there may be pockets that offer good appreciation.
DON'T SHUN EQUITIES ALTOGETHER
Fixed deposits and PPF may be safe but they won't prevent the eroding effect of inflation on your savings.
The only way to beat inflation is to invest in assets that can grow faster.
This is why even risk-averse investors should not shun equities completely.
You may not have the stomach for the ups and downs of the stock market but experts and statistics say equities are the only asset class that can beat inflation in the long term. For risk-averse investors, monthly income plans (MIPs) from mutual funds can be a lowrisk entry point to the equity markets.
MIP funds allocate only 10-25% of their corpus to equities and the rest to safer bonds and other debt instruments.
This is why returns from this category are fairly attractive when the going is good and stable over the long term. In the past one year, the average MIP fund has given a return of more than 4%.
